Video Reports

Embed this video

Copy Code

Link to this video

Get LinkEmbedLicenseRecommend (-)Print
Bookmark and Share

By Erik Kobayashi-Solomon | 04-30-2010 02:43 PM

A Utility Merger With Upside

The merger of RRI Energy and Mirant could create more synergies than the market currently believes says Morningstar energy analyst Mark Barnett.

Erik Kobayashi-Solomon: Hi, I'm Erik Kobayashi-Solomon, co-editor of Morningstar's OptionInvestor. Today, it's my great pleasure to welcome Mark Barnett, utilities analyst here at Morningstar.

Mark, thanks for coming.

Mark Barnett: Thanks, Erik. It's a pleasure to be here.

Kobayashi-Solomon: Just a couple of weeks ago, RRI Energy, an unregulated utility, announced that they were merging with Mirant, another unregulated utility. At the time, I wrote this option strategy, a bullish option strategy on RRI, and I just wanted to ask you a little bit about that.

Barnett: Sure.

Kobayashi-Solomon: First of all, big picture question: RRI and Mirant are both unregulated utilities. What's the difference between an unregulated and a regulated utility?

Barnett: That's a good place to start. About 50% of the country's markets, electricity markets, are regulated, meaning that you have elected officials or appointed government officials that work with utilities to set formulaic rates that they are able to charge.

Kobayashi-Solomon: This is what we see in the newspapers, going for a rate increase or something like that.

Barnett: Exactly. And while its sort of deceiving to call RRI and Mirant unregulated generators because they have to deal with environmental regulations, the power markets still operate under the overview of state governments and the federal government.

Basically, there is an actual market where the marginal cost of providing electricity is what you'll receive if you're going to the market that day and selling your power. So there's no intermediary saying, "This is what the rate payer wants to pay and this is what we think they should pay."

Kobayashi-Solomon: So basically the regulated utilities are saying, "We want to charge our customers this much." The unregulated utilities are kind of selling power into this power market.

Barnett: They're price-takers.

Kobayashi-Solomon: They're price-takers, OK. So what kind of effect does this have on them? Is this a good business? Is this a very volatile kind of business?

Barnett: Opinions vary on whether it's a good business. It certainly has looked great at times. It's an incredibly volatile business, especially on a year-to-year basis.

Kobayashi-Solomon: So it's not really what we'd think of as a utility, kind of a very staid thing. In other words, they're price-takers, they're kind of energy traders, basically.

Barnett: Right. The power markets themselves are very volatile. Your location, your fuel costs, the type of plant that you have can really leave you exposed to some pretty difficult pressures when the winds change, when people stop using electricity, when it's a hot day and you're not ready for it, that sort of thing. It's a very difficult business, and it's taken many a company down.

Kobayashi-Solomon: So RRI and Mirant have announced they're going to merge. Can you tell me a little bit more about this merger?

Barnett: Sure.

Kobayashi-Solomon: When is it going to happen? What's the idea?

Barnett: It's expected to close by the end of this year. The companies have said that they're pretty comfortable with the regulatory approvals. Now, typically the difficulty in a power merger is, is the combined entity going to have a lot of market power, too much generation in one location, for instance?

But as both of these companies are a little bit spread out and aren't as megalithic as, say, an Exelon or an NRG, that shouldn't be an issue.

Kobayashi-Solomon: So their geographical footprints don't really overlap then?

Barnett: Precisely. They'll have power plants in California. But they'll really be concentrated in the Mid-Atlantic region: Pennsylvania, Washington, D.C., more or less. So market power is really not much of an issue.

Read Full Transcript
{0}-{1} of {2} Comments
{0}-{1} of {2} Comment
  • This post has been reported.
  • Comment removed for violation of Terms of Use ({0})
    Please create a username to comment on this article